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Fed Misses Real Economy Again

Eighteen months ago, I accused the Fed of manipulating inflation data as well as constructing a deflation hoax. With hindsight, it appears that both accusations were correct. I also anticipated a rocky outcome when the Fed normalized unsustainably low interest rates. The consequence of that maneuver remains to be seen, but the outlook depends on the Fed's next move.

I can only fathom a guess as to why Fed officials manufactured that scare: In order to keep the economy cooking through his scheduled retirement, the Fed chairman required a not insignificant dose of artificial stimulus. Well aware of the wealth effect, especially from real estate appreciation, Greenspan initiated a bull market in property with artificially low interest rates. The deflation scare was just a ruse to camouflage his true stimulative intentions.

However, my column highlighted the obvious inflation risk last spring. Commodity prices were starting to advance. Service prices such as education, insurance, entertainment and health care premiums were rising rapidly. Real estate prices were soaring. The only real deflation out there was from Wal-Mart-purchased, Chinese-manufactured widgets. The only problem is this is a service economy and those expenditures were immune to Chinese competition -- and retail widgets are a small part of the economy anyway.

We all know what has happened to the headline CPI since, even with the hedonic adjustments.

Just as I disagreed with the Fed party line then, I dispute the inflation story today. It's funny how I disagree so often with the Fed's positions. It bought the New Economy silliness, I didn't. I foresaw rapidly building inflation pressures, they deflation risks. And now, as Fed governors incessantly highlight the perils of escalating prices, I perceive inflation risks as mitigating. The risk to the economy today is not runaway prices, but rather Fed Reserve vices. That's correct. The danger to this economy right now is the Fed's annoying, undesirable tendencies to push rate hikes much too far.

But wait a minute. With spiking commodity prices, low unemployment and rising capacity utilization rates, how can I be so sanguine regarding inflation? Don't I see the reported CPI and PPI data? Surely I of all people cannot buy that "core inflation" nonsense.

I do see the headline numbers. And we most certainly did experience a meaningful bout of inflation. However, the BLS mitigated its true scope with hedonic adjustments, unreal CPI component weightings, and nonsensical substitutions (the largest being owner's equivalent rent). In a perverse way, the "management" of the CPI kept the true pricing pressures out of inflation expectations and unit labor costs. Well, that and the outsourcing risk to the American work force.

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